Image © Bank of England
Superior "carry" is supporting Pound Sterling, for now.
While the UK was on holiday, the Pound to Euro exchange rate (GBP/EUR) also made the most of the sunshine and started the new week with a solid 0.30% advance, lifting it to a daily high of 1.1585 and back towards the top of a short-term range.
The gain takes GBP/EUR back above the nine-day exponential moving average, and while above here, we favour further gains and a test of the 1.16 range high.
The pair has struggled to advance beyond this point since July, meaning it's a level that would pose an immediate technical test to the advance.
With no major domestic calendar events due out of the EU, UK and U.S. this week, the foreign exchange market will likely see the final days of August play out in a relatively low volatility environment. (Donald Trump willing!).
This backdrop would typically support the Pound against the Euro, as it is usually better supported when all is calm and the market favours the "carry trade". This is where currencies underpinned by high interest rates outperform those with lower rates, and is one of the most potent forces in foreign exchange.
With Bank of England's Bank Rate at 4.0%, and the ECB's main deposit rate at half of this, it is clear to see that the Pound has the carry advantage.
"GBP is among the highest yielders in the developed world," says a note from the UBS CIO office. "We think that, absent any negative fiscal headlines, GBP will just 'carry on' for the time being."
The Bank of England cut Bank Rate on August 07 to 4.0% but signalled that numerous members of the Monetary Policy Committee were uncomfortable with the cut owing to persistently high inflation, which was confirmed by last week's consensus-beating inflation print of 3.8% year-on-year.
"The Bank of England has been easing policy only very cautiously given sustained inflationary pressures. These were highlighted once again in the latest CPI print, which again surprised to the upside. In the absence of more growth pain, this should prevent the BoE from cutting aggressively," says UBS.
Should the GBP/EUR exchange rate close above 1.16 at some point this week we would be alert to the prospect of a breakout of the summer range (1.16-1.1450). However, we are concious that on previous occassions moves above here soon faltered and the pair returned to the clutches of the range.
We would like to see a couple of daily closes above 1.16, close together, before turning more bullish.
Pound Sterling will likely struggle to find any meaningful upside momentum ahead of the Autumn budget as the UK braces for further tax hikes, as the government looks to plug its growing budget deficit.
This will elicit caution amongst businesses and households, which can suppress UK growth potential in the coming weeks.
"We increasingly see domestic factors and the relative growth outlook between the UK and the euro area as becoming GBP negatives. This is further amplified by divergence in the fiscal policy outlook with UK fiscal policy set to be tightened in the Autumn," says Danske Bank in a recent note.
Last week we reported the British Pound is facing comparisons with Britain’s 1976 currency crisis as economists warn of a dangerous mix of high inflation, weak growth and fiscal stress.
"For sterling, higher inflation alongside the backdrop of a weaker labour market makes for a challenging environment and as a result, the post-CPI lift in the pound has been unwound. A more stagflationary environment is a headwind for the currency," says Justin McQueen, a market analyst at Reuters.
So although we think near-term the Pound can gain, upside will be limited and a return to 2024 lows later in the year is possible.